A growing field

As healthcare captives continue their steady growth, Jeffrey S. Kenneson, senior vice president, business development for R&Q Quest Management Services, explores the reasons for their popularity and the factors to consider when setting up a captive.

There are many variables which dictate the segment growth and types of coverage included in captives. One of the best examples of segment growth fluctuation is construction. As the construction industry goes, so go the growth opportunities in the captives segment for these types of risks. The best example of coverage fluctuation is property. During times of relative calm with regard to catastrophic losses, for example hurricanes, property premiums in the traditional market are so cheap it doesn’t make sense to put any piece of that exposure through a captive.

As more property damage occurs due to these larger events, there is more investigation towards putting some layer of property risk through existing captives. Not so with the healthcare industry and the various medical/professional coverages associated with hospital and doctor groups.

Industries and business segments come and go in the captives industry, but the one constant growth area is healthcare and the various subsets of this industry. There are health systems, doctor groups, nursing homes, assisted living facilities, etc, all within this segment. As is the case with any other segment, the healthcare segment is looking for alternative insurance arrangements which will benefit their business by lowering the cost of insurance while providing the best care.

In more recent years, these captives have found opportunity in underwriting some of the risks of their Accountable Care Organizations (ACOs), a byproduct of the Affordable Care Act (ACA). Given the recent US election, stay tuned for what the future holds for ACOs. As most have heard, President-elect Trump has vowed to repeal and replace the ACA. Nobody knows what that will mean for healthcare in the coming year. Some of the provisions of the ACA are so embedded that they may be very difficult to repeal, while other provisions were considered improvements to the healthcare delivery system on a bipartisan basis—those provisions may also be too difficult to repeal.

Success stories

Captives will continue to be a strong vehicle for healthcare entities that wish to take better control of their insurance buying process and cost containment efforts. The majority of these captives have been successful—why is that? You’ll find that the successful captives have the buy-in of upper management and a commitment to the success of the entity, including the proper capitalization and funding of the entity. The risks are properly underwritten and premiums are charged according to the risk.

“These captive success stories are the result of knowledgeable service providers, proper structuring of the program and selecting the right domiciliary regulatory environment.”

Safety and loss control measures are implemented and followed with consequences for not meeting standards set by the board of the captive. In most cases, these safety and loss control measures are a prerequisite for the captive to offer coverage to a particular entity or division. Reinsurance support is strong with the board of the captive fostering positive relationships directly with the reinsurance carriers.

Along with a committed management team within the entity, these captive success stories are the result of knowledgeable service providers, proper structuring of the program and selecting the right domiciliary regulatory environment which fits the purpose of the captive. The healthcare entity should endeavor to hire the best actuary, auditor, captive manager, claims handler, investment advisor, and lawyer for their particular circumstances.

These individual firms can assist with the proper structuring of the captive in light of what the healthcare entity is looking to accomplish. Will the entity be a single parent captive, a group captive or a risk retention group? Will the captive entity be a wholly-owned captive or occupy a cell of another entity’s rental facility? For the wholly-owned captives, what form of ownership will there be, a stock company, a mutual company, a not for profit, a limited liability company or a reciprocal?

Choosing a home

During this process, these service providers can also assist with recommending the appropriate domicile for the regulation of the captive entity. If the entity form will be a risk retention group, one of the US domiciles would be required, but aside from this requirement, there are many variables to consider when choosing a domicile.

Does the domicile have the expertise, flexibility and capacity to regulate the entity? Is it a stable domicile with the longevity to show that it’s in the captives business for the long haul? Does it have the financial, legal and insurance infrastructure to support the captive? What are the costs to operate a captive in the domicile and what will the capitalization requirements be: not only the minimum statutory capital and surplus requirements but the premiums to surplus and capital ratios that regulators tend to adhere to for risk capital. Is the domicile accessible for annual board meetings or is it tough to travel to, which typically increases the administrative costs of operation?

A captive is a useful vehicle for an overall risk management program. It can be utilized to cover exposures that either can’t be insured in the traditional market or are prohibitively expensive to buy in the traditional market. By carving out a layer of exposure, the captive allows the healthcare entity to put skin in the game which shows the traditional carriers who are partnering with the captive that management is serious about cost containment. This gives the traditional carriers comfort when sharing the risk with the entity’s captive.

Captives are not an “be all, end all” type of vehicle for the various coverages in the healthcare industry. Given the potential catastrophic nature of the exposure, traditional carriers still need to be involved for the large losses that could occur. These carriers are more inclined to support the captive program on a reinsurance basis knowing that management is committed to cost containment with the use of a captive.

Although the vast majority of these captives are successful, there are always exceptions to the rule. In general, the unsuccessful captives are the ones that basically do the opposite of what the successful captives do: management is not committed to the captive idea, the captive is not properly underwritten or funded and due to the fact safety and loss control measures are inadequate or ignored, adverse development in the captive’s losses dictates the demise of these captives. Along with the fact that management is not committed to the strategies of the captive, the adverse loss development leads to the underfunding of these losses. Along with the lack of interest of management, the relationship building with the reinsurance market is lacking so the reinsurance support tends to be weak.
Future trends

As a company, we continue to see steady growth in the healthcare sector. Some of the more recent trends have to do with the expansion of existing health systems. We’ve seen many mergers and acquisitions between health systems and health systems acquiring doctor groups and doctor groups crossing state lines to acquire other doctor groups. This consolidation has created some very massive health systems, systems that look to their captive to cover their expanding risks and bring in their employed doctor groups under one “risk management/captive” arrangement.

We continue to see more health systems form their captives offshore, including systems that utilize trusts as a self-insurance mechanism. As health systems expand their reach and offer non-employed doctors insurance, the trust arrangement is not sufficient for this purpose, requiring the health system to move to a captive arrangement. We have no preference as to domicile, however—we are able to offer the pros and cons to each option and let the health system decide the proper venue.

Another interesting dynamic is the use of the reciprocal form of entity for the not-for-profit groups and for groups who have both for-profit and not-for-profit health systems intermingled. The reciprocal form under the IRS tax code allows the pass-through of the captives annual results to the membership/insureds to be included on the health system’s tax return. If set up properly with no tax timing differences at the captive level, the captive passes its net income through to the members/health systems who in turn pick up their share of the income on their parent company tax return. For the not-for-profit health systems, no tax is due and there is no tax at the captive level. These types of arrangement require a US domicile.

Given that the healthcare sector is one-sixth of the US economy, we see no letup in the formation of healthcare captives. For healthcare entities with management buy-in interested in exploring the feasibility of a captive arrangement, knowledgeable services providers with experience in the various types of captives, types of legal entities and domicile experience should be utilized to assist in forming and structuring the proper captive arrangement for your entity in the regulatory environment that best suits your needs.